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Question: The Monarch Bank Corp. has placed $100 million of GNMA-guaranteed securities in a trust account off the balance sheet. A CMO with four trenches has just been issued by Monarch using the ONMAs as collateral. Each tranche has a face value of $25 mil-lion and makes monthly payments. The annual coupon rate's are 4 percent for Tranche A, 5 percent for Tranche 8, 6 percent for Tranche C, and 7 percent for Tranche D.
a. Which tranche has the shortest maturity and which tranche has the most prepayment protection?
b. Every month principal and interest are paid on the outstanding mortgages and some mortgages are paid in full. These payments are passed through to Monarch and the trustee uses the funds to pay coupons to CMO bondholders. What are the coupon. payments owed for each tranche for the first month?
c. If scheduled mortgage payments and early prepayments bring in $1 million, how much will be used to retire the principal of CM() bondholders and which tranche will be affected?
d. Why does Tranche D have a higher expected return?
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